 What's Next for Silver?
By Doug Casey
The
International Speculator
Aug 22, 2006
A lot has happened since publishing "Silver on Sale,"
in the June 2004 edition of our International Speculator. As predicted in that article, the
price of silver has risen strongly, more doubling from $6.09
to the current $12.18, with a peak of as high as $15 in May.
The performance of silver has outshone even gold: silver was
up almost 31% in 2005, compared to gold's gain of almost 18%.
Now some investors are asking: "Was that it?" And if
we aren't near the top for silver, then how high will it go?
To answer those questions,
let's revisit the fundamentals, look at what specifically is
driving the market today and then make some predictions.
Silver-The Fundamentals
There are important differences
between silver and gold. The demand for gold is almost entirely
a demand for holding the stuff for financial purposes (protection
and profit) and for uses, such as jewelry. Very little gold is
actually consumed. In this respect gold is the polar opposite
of a base metal, such as iron, that people buy exclusively for
purposes that use it up. Silver has a foot in both worlds; some
is bought for uses that will consume it; other ounces are held
for financial protection or profit.
Most of the gold ever
mined (including the metal in Baal, Cleopatra's necklace and
what Alexander looted from the ancient cities of West Asia) remains
above ground in various easy-to-melt forms. The reasons for gold's
physical persistence are chemical - it is nearly inert, so it
doesn't corrode - and economic; because of its great value, very
little gets lost or discarded as waste. Annual mine production
is small compared to the existing stockpiles - on the same order
as the small amount of gold that is lost or consumed each year.
So the size of the existing stockpile doesn't change much. Fluctuations
in the price of gold come almost exclusively from fluctuations
in the demand to hold the stuff.
Ounces of silver, on the other
hand, come and go-not as quickly as tons of iron but as inevitably.
Silver, unlike gold, is chemically active. When silver is used,
much of it gets used up - consumed beyond practical recovery.
And because silver is so much less rare than gold, less effort
goes into salvaging and protecting it. Annual mine production
and consumption are large compared to existing stockpiles, so
fluctuations in price come from changes in both those factors
and also from changes in the demand to hold silver for financial
purposes.
Silver Today
The uses for silver in modern
industry are growing. It is the best conductor of both heat and
electricity, the most reflective, and (after gold) the second-most
ductile and malleable element. It is used in photography and
for many electrical applications, particularly in conductors,
switches, contacts and fuses. Silver alloys are used in batteries
as cathodes. As a bactericide, silver is used in water purification
and air-handling systems - we recently came across an ad for
a silver-lined washing machine that claims to need no detergent
to produce clean laundry.
The uses for silver are so
numerous that, despite the dwindling role in photography, you
can expect demand to remain strong as long as industrial economies
remain strong. And they have been so for some time now-with China
and India leading the charge.
But since the Hunt brothers'
ill-fated attempt to corner the silver market back in 1980, there
has been little investment demand for silver from the public
in developed countries. This has clearly and unequivocally changed,
as evidenced by the new silver exchange-traded fund (ETF) from
Barclays.
Supply Side
Most silver mines are really
lead-zinc-silver mines or copper-silver mines or gold-silver
mines, from which silver is a byproduct. In fact, 70% to 80%
of all silver comes as a byproduct of copper, lead and zinc mining.
Because the byproduct element is so large in the supply of new
silver, production doesn't respond much to price. This puts the
few mines that do produce primarily silver in an extremely risky
position. Over the last two decades, with silver being dug out
by copper, lead and zinc miners regardless of how low the price
went, most pure silver mines consistently lost money, and none
were especially profitable. For more than 20 years preceding
2003, no pure silver mining company generated free cash.
However, there are many known
silver deposits and proven reserves poised for production as
soon as silver crosses whatever price line makes them economically
viable. Furthermore, low silver prices don't necessarily halt
exploration: it's the prices of copper, lead and zinc that drive
exploration.
So, with silver hitting record
highs and base metals doing the same (increasing the flow of
silver as a byproduct), hundreds of millions more ounces of silver
will be heading for the market. According to the latest projections
in the CPM Group's CPM Silver Yearbook 2006, there may
even be a production-consumption surplus of 48.4 million ounces
of silver in 2006, the first such surplus since 1989. However,
those figures don't include investment demand. The production-consumption
surplus means that inventory will increase, but that still doesn't
tell us where the price is headed. If financial demand (to hold
silver for protection or profit) increases faster than the accumulating
physical inventory, the price will keep going up. But will it?
Demand
For one thing, consumption
has been eating into above-ground stocks of silver at a phenomenal
rate for decades, eroding total world bullion inventories from
an estimated 2.1 billion ounces in 1990 to around 400 million
ounces today - a drop of 1.7 billion ounces. A large chunk of
the drop, about 240 million ounces, came from government sales.
But that source is almost gone, with governments holding only
about 87 million ounces at the end of 2005.
For another, silver is like
uranium as an industrial metal, in that it is hard to replace
and it is used in such small relative quantities, that the price
could double or triple without having a major impact on industrial
usage. But the main reason, as mentioned above, silver is being
rediscovered as an investment vehicle, most notably in Barclays'
new silver ETF (SLV).
The advent of Barclays' silver
ETF has been a big factor in the price of silver lately, if only
through the expectations of speculators. The popularity of the
streetTRACKS Gold Shares ETF (GLD), which has raised $8.13 billion
since it began trading in November 2004, suggests that Barclays'
silver ETF will pull a lot of silver off the market. As of this
writing, August 7, 2006, it has already sucked up 92.4 million
ounces of silver. There goes the supposed surplus.
And as silver gets back on
trend, and gets noticed by an increasing number of investors,
the ETFs will make it easier for those investors to participate.
That is also true for certain institutions-most of which are
barred from owning physical metals - so they will, in essence,
uncork a latent source of investment demand. And Barclays' silver
ETF may be even more important than GLD. In Europe you have to
pay a VAT (17.5% in the UK) on the purchase of silver bullion
bars, as the metal is used in manufacturing. This is a blight
on active trading-a market niche the new ETF accommodates free
of VAT.
Throw in well-deserved concerns
about the U.S. dollar and about the at-least-it's-not-the-dollar
euro, and increased financial demand will almost certainly outstrip
any increase in global silver production for the next couple
of years. And, of course, if there's a major economic crisis,
the production-consumption surplus will be utterly swamped in
the mad dash to get out of paper and into precious metals - a
transition the ETFs will facilitate greatly.
What About Scrap Silver?
There is another potential
source of silver - the tons of it that people hold in the form
of old junk. If a high price for silver starts getting people
excited, won't the masses send their broken candlesticks and
seldom used spoons and trays to scrap dealers? Will that source
of supply turn into a flood, as it did so dramatically during
the 1980 price spike? At some price, yes - but probably not for
a while.
Stable higher prices will encourage
people to sell. But rising prices and the reasons for the growing
financial demand will encourage people to put off selling even
their unloved, broken candlesticks. Even as the incentive to
melt down Grandma's tea set increases, the "silver is money"
factor pushes the other way.
In 1974, silver was at $6.70,
about twice today's price in constant dollars, but supply from
all secondary sources was less than 170 million ounces. And in
1980, when silver reached its peak at $48.70 per ounce, secondary
sources provided just 302 million ounces-a big number, but nothing
like 20 billion ounces. Furthermore, the great bull market in
silver that ended in 1980 came after a hundred years in which
the public accumulated relatively cheap silver. A lot of that
was cleared out-melted down-in the early 1980s, and there hasn't
been as much time to replace it. Not only that, we suspect that
relatively few people have bought much made of pure silver since
1980; if you can't afford gold, why pay for solid silver when
you can get something electroplated that looks just as good for
a fraction of the cost?
Conclusions
Will silver hit its previous
1980 high? It was $48.70 then, but that's $120 in today's dollars
- almost 10 times the current price. Given that just below the
surface, the threats to the U.S. economy are even greater today
than in the late 1970s, we can easily envision silver closing
in on its previous high and even going way beyond it.
When will this come to pass?
No telling. But, periodic and inevitable corrections aside, it's
going to happen, of that we are confident. And, more to the point
of our service, when it does, the silver stocks we follow on
behalf of our readers won't just go to the moon, they'll leave
the solar system. To be sure you don't miss this profitable ride
on the resource bull market rocket, subscribe
to the International Speculator now.
-Doug Casey
The International Speculator
Casey Archives
321gold Inc
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